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Enforcement Roundup
With the CFTC still in the early stages of its fiscal year, in the month of November, we did not see a lot of action by way of publicly-released enforcement actions from the CFTC or enforcement-related public statements from the Commissioners or senior Division of Enforcement staff. We did see a $4 million award get issued to two whistleblowers (five people sought whistleblower awards for the same activity at issue) who provided key information leading to a successful enforcement action concerning the ongoing Traders Domain FX Ltd. litigation, which involves allegations of fraudulent misrepresentations and misappropriation of client funds.
While we are on the subject of whistleblowers, on November 15, 2024, the CFTC published its Whistleblower Program’s Annual Report for 2024, showing it was a record year for whistleblower tips and awards since the Program’s inception in 2010. In total in 2024, the CFTC granted 15 whistleblower award applications totaling over $42 million in award payments, including an $18 million award to one individual who contributed nonpublic information as well as his or her own analysis of public information that was “highly significant to the CFTC’s investigation,” and also led to another authority opening an investigation and bringing a related action. Collectively, these 15 whistleblower awards are associated with $162 million in monetary sanctions from enforcement actions.
The Report also highlights that in 2024, the CFTC brought its first enforcement action against a firm for impeding whistleblowing. In June 2024, the CFTC ordered Trafigura Trading LLC (“Trafigura”) to pay $55 million as a result of multiple violations, which included alleged violations for misappropriation of nonpublic information and manipulative conduct, but also for the first time in a CFTC enforcement action, impeding whistleblower communications with the CFTC by using broad non-disclosure provisions in employment and separation agreements. The CFTC found that Trafigura violated 17 C.F.R. 165.19, which makes it unlawful to “take any action to impede an individual from communicating directly with the Commission’s staff about a possible violation of the
Commodity Exchange Act,” including by enforcing, or threatening to enforce, a confidentiality agreement which restricts communication with the government.
You can read more about both updates here in our monthly enforcement roundup.
Tiffany Payne, Will Baxley, and Yiran Jiang | Email
Everything Can Be a Token
Well maybe not everything, but banks and market participants have been testing out and finding uses for the tokenization of different assets for quite some time. In response to the building fervor for the tokenization of everything, the CFTC’s Global Markets Advisory Committee recently released a report unanimously approving a recommended legal and regulatory framework for using distributed ledger technology (DLT) to transfer derivatives collateral in a manner consistent with U.S. regulatory requirements.
Specifically, the report discusses how the framework will address the use of DLT for assets already eligible to serve as regulatory margin. While the Commodity Exchange Act permits the use of non-cash collateral to satisfy margin requirements for uncleared swaps and sets out the fundamental characteristics such assets must comply with, the CFTC’s report states that none of those fundamental characteristics prescribe the “particular operational or technology infrastructure that a Swap Entity, derivatives clearing organization (DCO), or futures commission merchant (FCM) must use to effect transfers of, or record interests in, eligible collateral assets.”
Importantly, the “tokenization” of non-cash collateral assets addresses some of the challenges Swap Entities, FCM, and DCOs face when holding, transferring, liquidating, etc. non-cash collateral. Many market participants are already relying on DLT for “various types of ‘real world’ assets” to either document the assets in the institutions’ books and records or transfer ownership and other rights between entities using the ledger, which is often what market participants refer to as “tokenization”. The big advantage here is the opportunity/possibility to transfer assets in real-time, any time, and on any day thereby speeding up the transfer of non-cash collateral and increasing the pool of assets available for use.
The recommended legal and regulatory framework seeks to address (1) legal enforceability; (2) segregation and custody arrangements; (3) credit and custodial risks; and (4) information security and other operational risks. The specific recommendations for using DLT to hold and transfer non-cash collateral are to essentially follow your current information security and other relevant operational procedures if you use a DLT-infrastructure for books and records purposes; (2) apply existing policies, procedures, and practices for accepting eligible non-cash collateral; and (3) use existing policies, procedures, practices, and processes for assessing the use of new technologies and infrastructure for DLT.
While the report states “no new rules or guidance should be necessary”, the broader implementation of DLT to transfer non-cash collateral assets will undoubtedly raise new and novel legal and operational questions.
Barrett Morris | Email
CFTC Advisory on Clearing of Options on Spot Commodity ETFs + Archegos
This was in the “news” a lot in November (news here means if you regularly read about swaps and derivatives). We know you’ve read a lot about the CFTC’s Advisory, but we’d be remiss not to bring it up again here. We’ll keep the conversation brief and focused on my favorite sentence that occurs on the page split of the advisory and is worth calling out:
Although the Commission previously did not affirmatively determine whether options on Spot Commodity ETFs are “securities,” the staff believes that it is substantially likely that share of Spot Commodity ETFs (and the corresponding options) would judicially be held to be securities, based on the statutory framework of the securities laws and various court precedents. (emphasis added)
If you took nothing away from any other article or update on this Advisory, remember that sentence and you’ll have enough to stop and think back to this Advisory. Also, use of the word “judicially” is interesting considering the Advisory does not mention the Archegos case at all. That case is the one where the CFTC brought civil action in the U.S. District Court for the Southern District of New York against Archegos Capital Management and its CFO for a number of civil fraud violations. The District Court ultimately dismissed the CFTC’s action on the basis that the CFTC does not have jurisdiction over total return swaps on ETFs and certain “custom baskets”. These products, the District Court held, are under the exclusive jurisdiction of the Securities and
Exchange Commission. So, now the CFTC and the courts appear to be aligned on the “judicial” treatment of Spot Commodity ETFs.
Bill Hwang, the founder of Archegos, was sentenced in November to 18 years imprisonment for his role in the Archegos fraud and manipulation scheme.
Barrett Morris | Email
Federal Reserve Semiannual Supervision and Regulation Report
The Federal Reserve released its second semiannual Supervision and Regulation Report for 2024 last month. The Report is generally unexceptional – the U.S. banking system, by all identified measures, continues to remain strong and resilient. Banks continue to be well capitalized, benefit from lower funding risks than last year, and have experienced an increasing return on assets. Overall, these developments suggest the industry and markets have moved past the large bank failures that occurred in 2023. The more notable parts of the Report highlight (i) increasing concern around elevated delinquency rates for commercial real estate (CRE) and consumer lending, and (ii) an overall increase in supervisory findings for community, regional, and large banking
organizations primarily focused on deficiencies around governance and controls in connection with IT and operational resilience, third-party vendor management and efforts to remediate prior findings.
The risk around increased delinquencies in the CRE sector is particularly notable, and aligns with recent OCC guidance around managing the credit risk of refinancing CRE loans given the significant increase in loans reaching maturity in the next few years. For further analysis of the OCC guidance, see our overview here. Analysts and economists have highlighted credit risk in the CRE space since early 2024 when some large U.S. banks publicly announced they were increasing loss reserves in response to the threat. These delinquencies are primarily tied to office buildings in large cities, although the Report also notes increasing stress in the multifamily segment as well. Per the Report, delinquency rates at the largest banks for office loans have now hit their highest level since 2014 at 11% in Q2 2024. While the deterioration in the CRE space has been concentrated at large banks, delinquency rates for CRE loans at smaller banks have increased as well in the first half of 2024. Although the increased rates are concerning given that CRE loans have historically been a more stable
asset, and make up a larger portion of a bank’s loan portfolio, Federal Reserve interest rate cuts should provide some relief to borrowers moving forward.
As a result of the above, the Report notes that credit risk management (especially in the CRE and consumer lending context) and the management of IT, cybersecurity, and other operational risks are areas of supervisory focus.
John Lightbourne | Email
Bank Asset Sheets Are Big Again
Trading assets at US banks crossed $1 trillion at the end of the third quarter for the first time since 2008, according to a Financial Times analysis. This milestone, reminiscent of the Great Recession, raises concerns for some about potential risks – but it’s important to highlight that trading assets now account for just 4% of US banks’ assets, compared to 8% in 2008, and total value at risk is approximately half of what it was in 2008.
Assets have steadily climbed since the 2017 low, with a significant jump this year as banks have allowed significant cash to flow back to their trading accounts and invested mostly in equities and asset-backed securities linked to consumer credit card debt and auto loans. Analysts, like Bill Moreland of BankRegData, describe this shift as a focus on financial assets rather than broader economic lending.
Despite these figures, the industry argues that current risk levels remain significantly lower than in 2008. Importantly, the Dodd-Frank Act’s banking regulations (capital-focused regulations more specifically) provide some comfort according to the author by cutting how much a bank could lose in a single day to half of that level in 2008.
You may be thinking “Yiran, aren’t bank capital rules going to get more stringent under Basel Endgame?” Well, the Federal Reserve rolled back some of its implementation of Basel Endgame this summer, and a re-proposal is allegedly forthcoming, but likely delayed until we see new Chairs at the OCC and FDIC, who will need to endorse any changes to the Federal Reserve’s proposal. And, Chairman Jerome Powell has bluntly stated he is not going anywhere if the new administration asks him to step down.
Yiran Jiang | Email
UN Climate Conference – Article 6 and Carbon Credits
The UN Climate Conference (COP29) met in November and came to an agreement on the “final building blocks” that will set out how carbon markets will operate under the 2015 Paris Agreement (also known as Article 6), making country-to-country trading and the carbon crediting mechanism fully operational. Article 6’s main aim is to establish how countries can voluntarily buy, sell, and transfer carbon credits intended to both address climate change and raise financing for developing countries.
Key to the Article 6 building blocks that attendees of COP29 agreed to are clarity and transparency designed to ensure the integrity and ultimately the compliance of the carbon credits being traded. Notes from the conference state that “there is now reassurance that environmental integrity will be ensured up front through technical reviews in a transparent process.” The implementation of trading carbon credits under Article 6 has been nine years in the making and will continue during next year’s COP30.
Barrett Morris | Email
Interesting Links
IOSCO Pre-Hedging Consultation Report
Jolly Contrarian Updated Guidance on Cross Default
ISDA’s OTC Derivatives Compliance Calendar
Gary Gensler to Step Down January 20
Regulators to pause major proposals until Trump takes office (BASEL III)
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